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LONDON (Reuters) - Bank of England Governor Mark Carney signalled he was not concerned that Britain's economy was close to overheating, despite a strong recovery since last year, putting himself in the dovish camp among policymakers.
Speaking to lawmakers on Tuesday, Carney said the amount of spare capacity in the economy was probably slightly more than 1.5 percent of gross domestic product, suggesting the BoE can hold off on raising interest rates for longer.
Carney also said Britain's natural rate of unemployment could be less than the Bank has estimated, meaning the labour market can strengthen further without pushing up inflation.
Last month, the BoE put its assessments of spare capacity in the economy at the centre of its deliberations on when it will raise interest rates from a record low 0.5 percent, where they have stood since 2009 as Britain tries to recover from the financial crisis.
"We ranged in the February inflation report (that spare capacity) was 1-1.5 percent," Carney said in comments to the Treasury Select Committee in Britain's parliament.
"I personally would be at the upper end of that range and I would add that the margin, given the most recent employment report, that it would probably be slightly higher than that 1.5 percent."
Britain's unemployment rose to 7.2 percent in the three months to December, ending a string of falls that took the BoE by surprise.
Sterling weakened as Carney spoke. The pound has outpaced many other currencies in recent months on expectations that interest rates could rise in Britain before other economies.
In a sign of the different views among BoE policymakers on how long the economy can continue its recovery without fuelling inflation, Martin Weale - known as a hawk on the Monetary Policy
Committee - said he thought the amount of spare capacity was probably "something under 1 percent.
Financial markets have pointed to spring 2015 as a potential time for the first rate hike.
Output is still just below its peak in the first quarter of 2008 - a much weaker recovery from the financial crisis than in most other big advanced economies. The BoE is concerned that low productivity may limit Britain's ability to catch up without generating higher inflation in the medium term.
But Carney said productivity may be moving towards its long-term trend. "The most recent figures on productivity suggest around a 2 percent annualised growth rate, which is coming for the first time in a very long time towards trend."
When rate rises did come, they would be gradual, Carney said. Carney said he agreed with comments from Deputy Governor Charlie Bean on Monday that rates were unlikely to exceed 2.5 percent over the next three years.
In February, the BoE said the medium-term equilibrium rate of unemployment - meaning the lowest jobless rate the economy can maintain - was probably around 6 to 6.5 percent.
Carney suggested it could be lower.
"What we've learnt over the course of the last seven months since we put in place the first phase of forward guidance, or so what I've learnt, is that that equilibrium rate of unemployment has gone down," he said.
"It's lower than we would have thought in August and in August we estimated as a committee that it was about 6.5 percent. I personally would mark it around 6 now, potentially slightly lower."
Carney also said he was concerned that an improvement in the housing market could lead to a worsening of mortgage underwriting standards.
"Underwriting standards at present of mortgage providers are quite high...," he said. "Our concern is that those underwriting standards will deteriorate and that that deterioration itself would be fed by general improvement in the housing market."
Reporting by David Milliken, additional reporting by Ana Nicolaci da Costa and Paul Sandle, writing by Andy Bruce; editing by William Schomberg